Estate Planning 101: What is a “Sweetheart Trust?”
February 20 2014
By Hilary Lamar
When discussing your estate planning needs with your attorney, after you discuss basic terms and concepts, your attorney will likely talk to you about the different types of revocable living trusts that may be appropriate for you. If you are married, this may include a discussion about a revocable living trust structure commonly referred to as a “Sweetheart Trust.”
The Sweetheart Trust derives its name from the high level of control and discretion the surviving spouse maintains after the death of the first spouse. Initially, while both spouses are alive and competent, either spouse can revoke his or her share of the trust and the terms of the trust can usually be modified with the consent of both spouses. When one spouse dies, all trust assets remain in the same revocable trust for the lifetime of the surviving spouse. During the surviving spouse’s lifetime, he or she can terminate the trust, change its terms, add or remove beneficiaries, and otherwise manage the trust as he or she sees fit. Because the surviving spouse has complete and absolute control over the trust after the first spouse dies—in essence, an unconditional gift—this type of trust is called a Sweetheart Trust.
Many couples are attracted to the Sweetheart Trust because it achieves most of their estate planning goals in a relatively straightforward and simple trust structure. Although its structure is simple, a Sweetheart Trust still functions as a probate avoidance vehicle, which is the primary reason most people establish a trust. Additionally, due to the fact that all assets remain in the same revocable trust after the death of the first spouse, a Sweetheart Trust is generally easier and cheaper to administer upon the death of the first spouse and during the surviving spouse’s lifetime. No documentation is required to divide the trust, and no separate income tax returns are required. Additionally, since the surviving spouse does have complete discretion over how the property is managed after the death of the first spouse, this level of control mirrors that of the non-trust alternative: holding property in joint tenancy or as community property with right of survivorship (where the surviving joint owner inherits the property outright).
The Sweetheart Trust has gained more attention recently because of two changes in the Federal Estate Tax laws. First, the unified credit amount, which is the amount that can pass free of tax to anyone, has risen to over $5 million. Effectively, the Federal Estate Tax now is paid by less than 1% of decedent’s estates, which eliminates from most estate plans the estate tax avoidance benefits of a more complicated trust structure. Second, now that “portability“ is available, the surviving spouse may be able to use the unused unified credit of the deceased spouse, and so a married couple may be able to leave over $10 million to their heirs free of estate tax.
With all this said, it must be cautioned that a Sweetheart Trust is not right for everyone.
While a Sweetheart Trust is a great probate avoidance vehicle, it is not without its disadvantages. To begin with, due to the fact that the surviving spouse has the ability to change beneficiaries, a Sweetheart Trust is not usually appropriate in a blended family situation (where each spouse has different natural heirs). In such a situation, there is commonly a concern that the surviving spouse may be tempted to disinherit his or her stepchildren. Along these same lines, if a Sweetheart Trust is used and the surviving spouse remarries, he or she can modify the trust’s distribution provisions to leave part (or all) of the assets to the new spouse.
In addition, if the trust estate contains appreciating assets, such that there is a possibility that estate tax will be due upon the survivor’s death, other trust structures (such as an “A/B” or “A/B/C” trust) might prove more effective at reducing the likelihood of having to pay estate taxes upon the death of the surviving spouse. Of further note is the fact that although “portability” may allow the survivor to shelter over $10 million from estate taxes at his or her death, it does not allow the survivor to use the generation skipping transfer tax exemption of the deceased spouse, which reduces the amount that can be left in trust for the next generation to avoid estate taxes in that generation. The purpose of highlighting these scenarios is not to show that Sweetheart Trusts are always a bad idea—because they are not. Rather, it is to show that the high degree of control given to the surviving spouse can have certain consequences and both spouses need to be okay with them; and, that there may be some disadvantageous estate and generation skipping transfer tax consequences for larger estates. But if the disadvantages of the Sweetheart Trust are understood, and simplicity is the paramount concern of both spouses, then the relatively simple structure of a Sweetheart Trust may be the ideal probate avoidance vehicle.